Bank failures to surge in coming years

IndyMac, Corus, UCBH under pressure as credit crunch slows economy

By

AlistairBarr

SAN FRANCISCO (MarketWatch) -- By April, Gary Holloway was almost three years into retirement.

He'd built a new home by a lake in Texas, bought a boat and was working on his golf game. While taking on some part-time work, Holloway also traveled for months across the U.S. with his wife, from Seattle to Washington D.C., catching up with old friends and family.

That life of leisure abruptly changed about six weeks ago when Holloway got a phone call from his former employer, the Federal Deposit Insurance Corp., or FDIC, which regulates U.S. banks and insures deposits.

Holloway, a 30-year FDIC veteran, had worked extensively with failed lenders in Houston during the savings and loan crisis in the late 1980s and early 1990s, when thousands of thrifts collapsed.

Earlier this year, the FDIC began trying to lure roughly 25 retirees like Holloway back to prepare for an increase in bank failures. It's also hiring about 75 new staff.

Holloway quickly went back to work. ANB Financial N.A., a bank in Bentonville, Ark. with $2.1 billion in assets and $1.8 billion in customer deposits, was failing and an expert like Holloway was needed to value the assets and find a stronger institution to take them on.

"I was very excited about coming back," Holloway said in an interview. "I'm now 57. There's still a lot of life left and the juices are flowing again."

On May 9, life for ANB ended when the FDIC and the Office of the Comptroller of the Currency, another bank regulator, announced that the lender was closing. See full story.

Only three banks have failed so far in 2008. But that number is set to surge as the credit crunch slows economic growth and hammers some lenders that grew too fast during the recent real-estate boom, experts say.

The roots of today's banking crisis grew out of the boom and bust in the real estate market. Lenders originated more and more mortgages, while other banks, particularly smaller and medium-sized institutions, ploughed money into construction and development loans.

'You don't avoid the problem. It's too late to wait and hope that things get better.'
Joseph Mason, Drexel University

While loan growth soared in 2004 and 2005, most regulators failed to scrutinize many banks or restrain this heady expansion of credit. Now that the loans have been made and delinquencies are climbing, some banks may already be doomed.

Marriages and managing

"At this point in the crisis, you can't stop bank failures," said Joseph Mason, associate professor of finance at Drexel University's LeBow College of Business, who has studied past financial crises.

"At this point you manage through failures and arrange marriages where another stronger bank takes on the assets and deposits," he said. "You move through the problem. You don't avoid the problem. It's too late to wait and hope that things get better."

Things may get worse before they get better.

At least 150 banks will fail in the U.S. during the next two to three years, according to a projection by Gerard Cassidy and his colleagues at RBC Capital Markets.

'There has been excessive loan growth and some banks won't be able to access capital markets to replace the money that will disappear as credit losses rise.'
Gerard Cassidy, RBC Capital Markets

If the current economic slowdown deteriorates into a recession on the scale of those from the 1980s and early 1990's, the number of failures will be much higher this time around -- probably as high as 300 of them, by RBC's reckoning.

That's a massive surge compared to the recent boom years of the credit and real estate markets. From the second half of 2004 through end of 2006 there were 10 consecutive quarters without a bank failure in the U.S. -- a record length of time, Cassidy notes.

"This downturn will trigger a significant amount of bank failures relative to the past five years," he said. "There has been excessive loan growth and some banks won't be able to access capital markets to replace the money that will disappear as credit losses rise."

Texas Ratio

Cassidy and his colleagues have developed an early-warning system for spotting future trouble at banks called the Texas Ratio.

The ratio is calculated by dividing a bank's non-performing loans, including those 90 days delinquent, by the company's tangible equity capital plus money set aside for future loan losses. The number basically measures credit problems as a percentage of the capital a lender has available to deal with them.

Cassidy came up with the idea after covering Texas banks in the 1980s. Until the recession hit that decade, many banks in the state were considered some of the best in the country. But as problem assets climbed, that view was cruelly challenged, Cassidy recalls.

The analyst noticed that when problem assets grew to more than 100% of capital, most of the Texas banks in that precarious position ended up going under. A similar pattern occurred in the New England banking sector during the recession of the early 1990s, Cassidy said.

Along with his colleagues, Cassidy applied the same ratio to commercial banks at the end of this year's first quarter and found some disturbing trends.

UCBH Holdings Inc.
UCBH
a San Francisco-based bank, saw its Texas Ratio jump to 31% at the end of the first quarter from 4.7% in 2006, according to RBC.

The Texas Ratio of Colonial BancGroup
CNB, -1.22%
based in Montgomery, Ala., jumped from 1.5% in 2006 to 25% at the end of March.

Sterling Financial Corp.
STSA, +0.00%
headquartered in Spokane, Wash., had a Texas ratio of 1.9% in 2006. It was nearly 24% at the end of the first quarter, RBC data show.

These banks are no where near RBC's 100% critical threshold, and several lenders have raised new capital since the first quarter. For instance, National City Corp.
NCC, +0.43%
topped RBC's list with a Texas Ratio of 40% at the end of March, though the bank did raise $7 billion in new capital in April.

"But these ratios have skyrocketed in recent years," Cassidy warned. "If that trend continues, some of these banks may be in trouble."

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